Sam Bankman Unfreed: What the FTX case means for cryptocurrency regulation
Photo Courtesy: Bybit/Ricky Redor (via Openverse)
On the 11th August 2023, Judge Lewis Kaplan ruled that Sam Bankman-Fried (SBF) had violated the terms of his bail, by contacting potential witnesses and using a Virtual Private Network to subvert the monitoring of his internet activity.
SBF, who had previously been charged with two counts of wire fraud and conspiracy to commit money laundering, now faces a number of charges as a result of his misconduct whilst in charge of FTX.
But what really happened to FTX? What effects has the platform’s downfall had on the cryptocurrency market as a whole? And what, if any, positive outcomes can we hope to arise from the biggest collapse in corporate America since the Enron scandal?
What happened to FTX?
Future Exchange (FTX) was one of the largest cryptocurrency exchanges in the world. It was a platform that allowed users to trade multiple digital currencies, including FTX’s own token, FTT. Importantly, to avoid the scrutiny of US banking and transaction regulations, the company was based in the Bahamas and spent a lot of their operating period hoping to lobby legislators to implement crypto-friendly bills.
On the 2nd November 2022, Coindesk - an online news platform specialising in digital currencies - published this article. It stated that Alameda Research, a parent company owned by SBF, held a significant amount of FTX’s own token - tens of millions of FTT. This masked the true value of FTT, led to the price of FTT being artificially inflated, and allowed parent company Alameda Research to remain afloat.
In response to these allegations, Binance - a rival cryptocurrency exchange - stated they would be selling all of their FTT holdings. This caused the price of the token to crash, and in turn prompted many investors to not only sell their own holdings, but further withdraw all the capital they had accumulated with FTX. Within a few days, FTX reported they would require $8 billion in funding as they did not have the reserves to handle all their investors closing their accounts at once.
On the 8th November 2022, Binance signed an offer to acquire FTX, only to withdraw from the deal a day later. Changpeng Zhao, the chief executive of Binance, later cited both the investigations that were ongoing into FTX’s business practices and the mishandling of customer funds as reasons for pulling out of the deal.
FTX then filed for Chapter 11 bankruptcy on the 11th November. Under this provision, the debtor can remain in possession of their assets and may continue to operate their business by the approval of the court. The then CEO of FTX, John Ray III, stated that funds had been misused, with “only a fraction” of digital funds being returned to their investors. In reality, SBF had misappropriated funds to purchase homes within the Bahamas.
The Aftermath
The effects of FTX’s bankruptcy were consequently felt across the cryptocurrency market. Bitcoin, one of the most popular cryptocurrencies in the world, lost 75% of its value, falling to less than $17,000. The exchange token of Crypto.com, Cronos, lost close to $1 billion in value. Gemini, a separate cryptocurrency exchange company, was forced to pause all withdrawals from their Earn program, as fears of multiple smaller bankruptcies grew.
Whilst companies suffered such financial downturns, the US attorney for the Southern District of New York announced that a formal investigation into FTX’s collapse had begun on the 14th November. On the 13th December, Damian Williams (US Attorney for the Southern District of New York), Merrick B. Garland (US Attorney General), and Michael J. Driscoll (Assistant Director in Charge of the New York Field office of the FBI) announced that SBF would be facing a plethora of criminal charges. These included conspiracy to commit securities fraud and conspiracy to commit money laundering. On the 21st December, SBF was extradited to the United States to face prosecution for his role in the collapse, whilst several other executives within FTX were informed they too were under investigation.
Globally, $1.4 trillion of value was wiped clean during the course of 2022. FTX was cited as the primary reason for this collapse in value, which in turn undermined the reputation of several other platforms. BlockFi was unable to operate as normal, halting all client withdrawals until August 17 2023, when a court order forced the platform to allow US clients to withdraw any assets from their accounts.
Regulation
The problems that FTX encountered reflect many of the most common issues with the wider cryptocurrency industry. Regulators have previously struggled with the nature of crypto as it is incredibly volatile. It also proves immensely difficult to trace most transactions, as many crypto currency wallets are identified in hexadecimal and not with names on the Blockchain.
Consequently, in January 2023, the US Federal Reserve, FDIC, and OC released a statement warning against such issues. Whilst no new laws were announced at the time, the Securities and Exchange Commission (SEC) announced in October that it would be increasing the number of staff in its cryptocurrency enforcement unit by 40%, to tackle the market’s ever rising numbers of collapses and scams. Official laws are also being drafted, with several legislations pending approval in New York, including laws surrounding disclosure and virtual token fraud.
The UK responded to the collapse of FTX by passing the Financial Services and Markets Act 2023. This introduced regulation for so-called “stable coins”, referring to crypto assets that are backed by a more stable asset, typically currency. It is the first piece of legislation designed to regulate any form of crypto assets within the United Kingdom.
Sir Jon Cunliffe, deputy governor for financial stability at the Bank of England, has stated that whilst crypto is not “large enough” to pose a risk at this current stage, the rapidly developing nature of the space means further regulation and guarantees will be needed to protect financial markets. Governments around the world have often been slow to respond to the problems within the cryptocurrency market. But perhaps now, as a consequence of the fall of FTX and Sam Bankman-Fried, more legislation will be passed, and more attempts made to prevent another scandal of this scale.